INDEPENDENT BANKSHARES INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number: 0-10196

INDEPENDENT BANKSHARES, INC.
(Exact name of registrant as specified in its charter)

Texas (State or other jurisdiction of incorporation or organization)		75-1717279 (I.R.S. Employer Identification No.)
1617 Broadway P. O. Box 5240 Lubbock, Texas (Address of principal executive offices)		79408 (Zip Code)

(806) 749-1850
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

YES ý NO o

Indicate the number of shares outstanding of each of the issuer's classes of common stock at September 30, 2002.

Class: Common Stock, par value $0.25 per share Outstanding at September 30, 2002: 2,273,647 shares

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

INDEPENDENT BANKSHARES, INC.
A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.

CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001

(Unaudited)
(In Thousands)

				September 30, 2002			December 31, 2001
ASSETS
Cash, due from banks and interest-earning time deposits				$	20,233		$	36,062
Federal funds sold					9,313			10,528

	Total cash and cash equivalents				29,546			46,590
Available-for-sale securities					191,830			216,112
Loans held for investment					286,936			304,246
	Allowance for loan losses				(6,929	)		(6,525	)

		Net loans			280,007			297,721

Goodwill					16,098			31,740
Core deposit intangible					10,552			11,979
Premises and equipment					14,778			15,380
Other assets					19,301			17,861

			Total assets	$	562,112		$	637,383

LIABILITIES AND STOCKHOLDER'S EQUITY
Deposits:
	Noninterest-bearing demand deposits			$	96,988		$	112,044
	Interest-bearing demand deposits				178,520			180,021
	Interest-bearing time deposits				204,294			251,965

		Total deposits			479,802			544,030
Federal funds purchased and securities sold under agreements to repurchase					191			151
Other liabilities					6,939			6,903

			Total liabilities		486,932			551,084

Guaranteed preferred beneficial interests in the company's subordinated Debentures					10,930			10,918
Stockholder's equity:
	Common stock				568			568
	Additional paid-in capital				80,066			80,071
	Retained earnings (deficit)				(20,772	)		(8,280	)
	Accumulated other comprehensive income				4,388			3,022

		Total stockholder's equity			64,250			75,381

			Total liabilities and stockholder's equity	$	562,112		$	637,383

See Accompanying Notes to Interim Consolidated Financial Statements.

INDEPENDENT BANKSHARES, INC.
A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE QUARTERS AND NINE MONTH PERIOD ENDED SEPTEMBER 30, 2002 AND 2001

(Unaudited)
(In Thousands)

				Quarter Ended September 30,					Nine Month Period Ended September 30,
				2002		2001			2002			2001
Interest income:
	Loans, including fees			$	5,059	$	6,501		$	15,280		$	21,374
	Securities				2,515		2,806			8,122			8,410
	Deposits in other banks				27		5			72			19
	Federal funds sold				51		614			205			2,307

		Total interest income			7,652		9,926			23,679			32,110

Interest expense:
	Deposits				1,890		4,445			6,517			15,728
	Federal funds purchased and securities sold under agreements to repurchase				0		1			1			3

		Total interest expense			1,890		4,446			6,518			15,731

			Net interest income		5,762		5,480			17,161			16,379
Provision (credit) for loan losses					78		1,000			(77	)		5,565

			Net interest income after provision (credit) for loan losses		5,684		4,480			17,238			10,814

Noninterest income:
	Service charges				940		810			2,907			2,544
	Trust fees				117		113			369			381
	Other income				527		359			1,416			986

		Total noninterest income			1,584		1,282			4,692			3,911

Noninterest expenses:
	Salaries and employee benefits				2,763		2,620			7,795			8,175
	Amortization of goodwill				0		458			0			1,371
	Amortization of core deposit intangible				472		566			1,416			1,697
	Net occupancy expense				982		960			2,864			2,812
	Professional fees				174		120			527			672
	Distributions on guaranteed preferred beneficial interests in the company's subordinated debentures				280		280			840			839
	Communication expense				200		242			606			685
	Data processing expense				104		156			399			493
	Net costs (revenues) applicable to other real estate and other repossessed assets				12		56			10			44
	Merger-related expense				0		0			0			51
	Other expenses				1,002		1,038			3,023			3,244

		Total noninterest expenses			5,989		6,496			17,480			20,083

			Income (loss) before federal income taxes and cumulative effect of a change in accounting principle		1,279		(734	)		4,450			(5,358	)
	Federal income tax expense (benefit)				264		(178	)		1,302			(1,553	)

			Income (loss) before cumulative effect of a change in accounting principle		1,015		(556	)		3,148			(3,805	)
	Cumulative effect of a change in accounting principle—goodwill impairment				0		0			15,642			0

			Net income (loss)	$	1,015	$	(556	)	$	(12,494	)	$	(3,805	)
Other comprehensive income, net of taxes:
	Change in unrealized holding gains on available-for-sale securities				873		1,391			1,367			2,495

			Comprehensive income (loss)	$	1,888	$	835		$	(11,127	)	$	(1,310	)

See Accompanying Notes to Interim Consolidated Financial Statements.

INDEPENDENT BANKSHARES, INC.
A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 and 2001

(Unaudited)
(In Thousands)

			Nine Month Period Ended September 30,
			2002			2001
Cash flows from operating activities:
	Net Loss		$	(12,494	)	$	(3,805	)
Adjustments to reconcile net loss to net cash provided by operating activities:
	Depreciation and Amortization			3,034			3,856
	Provision (credit) for Loan Losses			(77	)		5,565
	Cumulative Effect of a Change in Accounting Principle—Goodwill Impairment			15,642			0
	Net (Gain) Loss on Sales of Premises and Equipment			5			(23	)
	Writedown of Premises and Equipment			82			0
	Gain on Sale of Investments			(12	)		(1	)
	Net Gains on Sales of Other Real Estate and Other Repossessed Assets			(8	)		(30	)
	Writedown of Other Real Estate and Other Repossessed Assets			0			36
	Decrease in Other Assets			366			2,012
	Decrease in Other Liabilities			(675	)		(5,602	)

		Net Cash Provided by Operating Activities		5,863			2,008

Cash Flows from Investing Activities:
	Proceeds from Maturities of Available-for-sale Securities			84,058			54,589
	Proceeds from Sales of Available-for-sale Securities			1,414			59,919
	Purchases of Available-for-sale Securities			(59,602	)		(137,080	)
	Purchase of Bank Owned Life Insurance			(1,994	)		(10,000	)
	Net Decrease in Loans			16,360			41,459
	Proceeds from Sales of Premises and Equipment			68			329
	Sale of Branch			(3,519	)		0
	Additions to Premises and Equipment			(957	)		(1,473	)
	Proceeds from Sales of Other Real Estate and Other Repossessed Assets			259			831

		Net Cash Provided by Investing Activities		36,087			8,574

Cash Flows from Financing Activities:
	Decrease in Deposits			(59,034	)		(25,548	)
	Increase in Federal Funds Purchased and Securities Sold under Agreements to Repurchase			40			200
	Advances from Parent Company			0			1,000
	Payment of Cash Dividends			0			(700	)

		Net Cash Used in Financing Activities		(58,994	)		(25,048	)

Net Increase (Decrease) in Cash and Cash Equivalents				(17,044	)		(14,466	)
Cash and Cash Equivalents at Beginning of Period				46,590			85,185

Cash and Cash Equivalents at End of Period			$	29,546		$	70,719

Noncash Investing Activities:
	Additions to Other Real Estate and Other Repossessed Assets through Foreclosures		$	394		$	884

See Accompanying Notes to Interim Consolidated Financial Statements.

INDEPENDENT BANKSHARES, INC.
NOTES TO INTERIMCONSOLIDATED FINANCIAL STATEMENTS

(1) Summary of Significant Accounting Policies

For information with regard to significant accounting policies, reference is made to Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2001, which was filed with the Securities and Exchange Commission pursuant to Section 13 of the Securities and Exchange Act of 1934, as amended.

The accompanying financial statements reflect all adjustments necessary to present a fair statement of the results for the interim periods presented, and all adjustments are of a normal recurring nature.

(2) Bank Mergers

On February 28, 2001, State National Bancshares, Inc. ("State National"), Independent Bankshares, Inc.'s (the "Company") sole shareholder, contributed its ownership interest in State National Bank of West Texas, Lubbock, Texas ("the Lubbock Bank"), an indirect wholly owned subsidiary of State National, to the Company. The Company in turn, contributed to Independent Financial Corp., a Delaware subsidiary of the Company, all of the capital stock of the Lubbock Bank. On March 9, 2001, the State National Bank of West Texas, Abilene, Texas (the "Abilene Bank"), an indirect wholly owned subsidiary of the Company, was merged (the "Lubbock Merger") with and into the Lubbock Bank. The Lubbock Bank continued as the surviving entity in the Lubbock Merger (the "Bank") and is an indirect wholly owned subsidiary of the Company. There was no merger consideration paid as, prior to the Lubbock Merger, the Abilene Bank and the Lubbock Bank were both direct or indirect subsidiaries of State National. The balance sheet and results of operations of the Lubbock Bank have been included in the Company's consolidated financial statements since August 11, 2000, the date of acquisition of the Company by State National. At August 11, 2000, the Lubbock Bank had total assets of $210,409,000, total deposits of $190,828,000, total loans of $121,130,000 and stockholder's equity of $18,405,000. References made to the Company include all of the Company's subsidiaries unless specifically noted otherwise.

(3) Accumulated Other Comprehensive Income

An analysis of accumulated other comprehensive income for the quarters and nine-month periods ended September 30, 2002 and 2001, is as follows:

		Unrealized Gain (Loss) on Available-for-sale Securities, net
		Quarter Ended September 30,				Nine Month Period Ended September 30,
		2002		2001		2002		2001
		(In thousands)
Balance, beginning of period		$	3,516	$	2,722	$	3,022	$	1,618
Current period change			873		0		1,367		1,104

	Balance, at September 30	$	4,389	$	2,722	$	4,389	$	2,722

(4) Adoption of Accounting Standards and Goodwill Impairment

The Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141, Business Combinations ("Statement 141"), and Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets ("Statement 142"). Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001.

Statement 141 also included guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized.

Statement 142 was effective for the Company's fiscal year beginning January 1, 2002. The implementation of Statement 142 resulted in the Company recording a one-time, non-cash, goodwill impairment charge of $15,642,000 during the first quarter of 2002. This charge reflects the cumulative effect of adopting the accounting change in the statement of operations, but does not affect the Company's operations and has no impact on cash flows. The application of the nonamortization provisions of Statement 142 resulted in an increase in net income before federal income taxes and cumulative effect of a change in accounting principle of $1,297,000 for the nine month period ended September 30, 2002 and is expected to result in an increase in net income before federal income taxes and cumulative effect of changes in accounting principle of $1,730,000 pre tax for the year ended 2002.

Intangibles consist of the following:

			September 30, 2002				September 30, 2001
		Average Life (Yrs)	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Amortized Intangible
	Core Deposit Intangible	10	$	17,080,000	$	6,528,000	$	16,961,000	$	3,525,000
Intangible Assets Not Subject to Amortization
	Goodwill		$	16,098,000	$	0	$	35,827,000	$	3,309,000
Aggregate Amortization Expense:
	For the nine month period ended September 30, 2002				$	1,416,000

Aggregate Amortization Expense is anticipated to be as follows for the year ended December 31:

2002	$	1,873,000
2003		1,639,000
2004		1,512,000
2005		1,480,000
2006		1,432,000

Total	$	7,936,000

The change in the carrying amount of goodwill for the nine month period ended September 30, 2002 is as follows:

Balance as of January 1, 2002	$	31,740,000
Impairment Loss		(15,642,000	)

Balance as of September 30, 2002	$	16,098,000

Substantial loan charge offs that occurred during the year in 2001 were attributable to loans that were carried by the Company at the date of Acquisition of the Company by State National. As a result of charged-off loans, management of the Company required that other related loans be paid off thereby generating a further reduction in loans. The significant time devoted by management and

various loan officers to identify and charge off problem loans and to facilitate the early pay offs of related loans resulted in a slowing of loan growth to new and existing customers of the Bank. The overall reduction in fair value of the Company primarily resulting from these factors along with other factors caused an impairment of $15,642,000 to be calculated under the guidance established by Statement 142 and recorded in the first quarter of 2002 to the goodwill associated with the Acquisition. The fair value of the Company was calculated through a combination of the market comparison, asset value, earnings value and acquisition analysis methods by a third party.

The following table adjusts earnings for the adoption of Statement 142.

				Quarter Ended September 30,					Nine Month Period Ended September 30,
				2002		2001			2002			2001
Reported Net Income (Loss)				$	1,015,000	$	(556,000	)	$	(12,494,000	)	$	(3,805,000	)
	Add Back Goodwill Amortization				0		458,000			0			1,371,000

			Adjusted Net Income (Loss)	$	1,015,000	$	(98,000	)	$	(12,494,000	)	$	(2,434,000	)
	Add Back Cumulative Effect of a Change in Accounting Principle				0		0			15,642,000			0

		Adjusted Net Income (Loss) If Statements 142 had not been Adopted		$	1,015,000	$	(98,000	)	$	3,148,000		$	(2,434,000	)

(5) Branch Sale

On July 1, 2002 the Bank sold its branch in Bangs, Texas to an unrelated financial institution. At July 1, 2002 the branch had total assets of $1,609,000, total loans, net of allowance for loan loss of $1,263,000 and total deposits of $5,194,000. A loss of $21,000 was recorded related to this transaction. Net income for the period ended June 30, 2002 for this branch was $44,000.

(6) Subsequent Event

On October 11, 2002 the Bank sold its branch in Trent, Texas to an unrelated financial institution. On this date, the branch had total assets of $1,582,000, total loans, net of allowance for loan loss of $1,446,000 and total deposits of $9,164,000. A loss of $13,000 was recorded related to this transaction. Net income for the period ended September 30, 2002 for this branch was $43,000. The effect of this transaction is not reflected in the financial statements as of and for the period ended September 30, 2002.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains certain forward-looking statements and information relating to Independent Bankshares, Inc. (the "Company", and at or prior to the date of the Acquisition, "IBK") and its subsidiaries that are based on the beliefs of the Company's management as well as assumptions made by and information currently available to the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements are intended to be covered by the safe-harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and we are including this statement for purposes of invoking those safe harbor provisions. These forward-looking statements reflect the current view of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions, many of which are beyond the Company's control, related to certain factors including, without limitation, competitive factors, general economic conditions nationally and within the State of Texas, customer relations, the interest rate environment, governmental regulation and supervision, nonperforming asset levels, loan concentrations, changes in industry practices, acts of terrorism and war, one time events and other factors described herein. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Company does not intend to update these forward-looking statements.

The Company

The Company is a bank holding company headquartered in Lubbock, Texas. The Company is an indirect wholly owned subsidiary of State National Bancshares, Inc., Lubbock, Texas ("State National"). State National acquired the Company at the close of business on August 11, 2000, in an all cash transaction (the "Acquisition"). At September 30, 2002, the Company owned all of the common securities of Independent Capital Trust ("Independent Capital") and indirectly owned through a Delaware subsidiary, Independent Financial Corp. ("Independent Financial"), 100% of the stock of State National Bank of West Texas, Lubbock, Texas (the "Bank"). At September 30, 2002, the Company operated full-service banking locations in the Texas cities of Abilene (four locations), Azle (two locations), Big Spring, Lubbock (three locations), Odessa (two locations), Plainview, San Angelo, Stamford, Trent and Winters. On October 11, 2002, the Company sold its branch in Trent, Texas to an unrelated financial institution. The Company has sold some of its smaller branches in an effort to streamline its services and concentrate on the larger market areas.

General

The following discussion and analysis presents the more significant factors affecting the Company's results of operations for each of the quarters and nine-month periods ended September 30, 2002 and 2001, and the financial condition at September 30, 2002, and December 31, 2001. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements, notes thereto and other financial information appearing elsewhere in this quarterly report.

Analysis of Results of Operations

Net Income (Loss)

Net income for the quarter ended September 30, 2002 amounted to $1,015,000 compared to net loss of $556,000 for the quarter ended September 30, 2001. Net income before cumulative effect of a change in accounting principle for the nine month period ended September 30, 2002 was $3,148,000 compared to net loss before cumulative effect of a change in accounting principle of $3,805,000 for the nine month period ended September 30, 2001. The increase in net income between the quarter ended

September 30, 2002 compared to the quarter ended September 30, 2001 as well as the increase in net income before cumulative effect of a change in accounting principle for the nine month period ended September 30, 2002 compared to the nine month period ended September 30, 2001 was primarily due to the reduction of the provision for loan loss recorded in the nine month period ended September 30, 2002 as compared to the loan loss provision recorded for the same periods in 2001 and the discontinuation of goodwill amortization beginning January 1, 2002 due to the adoption of Statement 142. Giving effect to the cumulative effect of a change in accounting principle, net loss for the nine month period ended September 30, 2002, was $12,494,000 compared to net loss of $3,805,000 for the nine month period ended September 30, 2001. The loss in the nine month period ended September 30, 2002 was due to a $15,642,000 impairment recorded in the first quarter of 2002 as a cumulative effect of a change in accounting principle, related to the adoption of Statement of Accounting Standards, No. 142 "Goodwill and Other Intangible Assets" ("FAS 142").

Net Interest Income

Net interest income represents the amount by which interest income on interest-earning assets, including loans and securities exceeds interest paid on interest-bearing liabilities, including deposits and other borrowed funds. Net interest income is the principal source of the Company's earnings. Interest rate fluctuations, as well as changes in the amount and type of interest-earning assets and interest-bearing liabilities, combine to affect net interest income.

Net interest income amounted to $5,762,000 for the third quarter of 2002, an increase of $282,000, or 5.15%, when compared to the second quarter of 2001. Net interest income for the third quarter of 2001 was $5,480,000. Net interest income for the first nine months of 2002 was $17,161,000, an increase of $782,000, or 4.77%, when compared to net interest income of $16,379,000 for the first nine months of 2001. Net interest margin on a fully taxable-equivalent basis increased from 3.89% for the third quarter of 2001 to 4.66% for the third quarter of 2002, as well as from 3.80% for the first nine months of 2001 to 4.51% for the first nine months of 2002. The decreases in the prime interest rate during 2001 began in January 2001. During the quarter and the nine month period ended September 30, 2001, in which the prime interest rate decreased from 6.75% to 6.00% and from 9.5% to 6.00%, respectively, interest earning assets were repricing faster than interest bearing liabilities, thereby pulling the net interest margin at September 30, 2001 down. During the nine month period ended September 30, 2002, there have been no reductions in the prime interest rate. This allowed the repricing lag effect of interest bearing liabilities to be reduced and creates an upward trend in the net interest margin from September 30, 2001 to September 30, 2002.

At September 30, 2002, approximately $141,159,000, or 49.20%, of the Company's total loans, net of unearned income, were loans with floating interest rates. During 2001, loans with floating interest rates had been subjected to rapidly declining interest rates. In addition, total loans, net of unearned income, decreased $30,753,000 since September 30, 2001. The declining interest rates were the primary cause of the decrease in loan yields from 8.56% at September 30, 2001 to 7.21% at September 30, 2002.

Security yields decreased from 6.53% at September 30, 2001 to 5.33% at September 30, 2002. This decrease was primarily caused by declines in yields in the bond market on new purchases between the periods ended September 30, 2001 and September 30, 2002.

These net changes caused the Company's overall yield on interest earning assets to decrease from 7.01% for the quarter ended September 30, 2001 to 6.18% for the quarter ended September 30 2002, and to decrease from 7.42% to 6.21% for the nine month period ended September 30, 2001 and 2002, respectively.

Average overall rates paid for various types of certificates of deposit decreased when comparing the first nine months of 2001 to the first nine months of 2002. For example, the average rate paid for

certificates of deposit less than $100,000 decreased from 5.56% for the first nine months of 2001 to 3.10% for the first nine months of 2002, while the average rate paid by the Company for certificates of deposit of $100,000 or more also decreased from 5.89% during the first nine months of 2001 to 3.35% during the first nine months of 2002.

Rates on other types of deposits, such as interest-bearing demand, savings and money market deposits, also decreased from an average of 2.10% during the nine month period ended September 30, 2001 to an average of 0.86% during the first nine months of 2002. These decreases were primarily caused by the rapidly declining interest rate environment, which existed during the time period from September 30, 2001 to September 30, 2002. These changes caused the Company's overall cost of interest-bearing deposits to decrease from 4.31% for the first nine months of 2001 to 2.12% for the first nine months of 2002.

The following table presents the average balance sheets of the Company for the quarters and nine month periods ended September 30, 2002 and 2001, and indicates the interest earned or paid on the major categories of interest-earning assets and interest-bearing liabilities on a fully taxable-equivalent basis and the average rates earned or paid on each major category. This analysis details the

contribution of interest-earning assets and the impact of the cost of funds on overall net interest income.

				Quarter Ended September 30,
				2002							2001
				Average Balance			Interest Income/ Expense		Yield/ Rate		Average Balance			Interest Income/ Expense		Yield/ Rate
				(Dollars in thousands)
ASSETS
Interest-earning assets:
	Loans, net of unearned income(1)			$	282,552		$	5,059	7.16	%	$	313,939		$	6,501	8.28	%
	Securities(2)				197,720			2,550	5.16	%		184,036			2,855	6.21	%
	Interest-earning time deposits in other banks				4,723			27	2.29	%		502			5	3.98	%
	Federal funds sold				12,781			51	1.60	%		70,394			614	3.49	%

		Total interest-earning assets			497,776			7,687	6.18	%		568,871			9,975	7.01	%

Noninterest-earning assets:
	Cash and due from banks				18,548							30,683
	Intangible assets				26,780							46,498
	Premises and equipment				14,516							16,050
	Accrued interest receivable and other assets				19,590							20,533
	Allowance for possible loan losses				(6,922	)						(4,399	)

		Total noninterest-earning assets			72,512							109,365

			Total assets	$	570,288						$	678,236

LIABILITIES AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
	Interest-bearing, savings and money market deposits			$	184,028		$	382	0.83	%	$	191,491		$	759	1.59	%
	Time deposits				207,515			1,508	2.91	%		282,759			3,686	5.21	%
	Federal funds purchased and securities sold under agreements to repurchase				142			0	0.00	%		186			1	2.15	%

			Total interest-bearing liabilities		391,685			1,890	1.93	%		474,436			4,446	3.75	%

Noninterest-bearing liabilities:
	Demand deposits				97,758							103,096
	Accrued interest payable and other liabilities				6,709							8,458

		Total noninterest-bearing liabilities			104,467							111,554

			Total liabilities		496,152							585,990
Guaranteed preferred beneficial interests in the Company's subordinated debentures					10,928							10,923
Stockholder's equity					63,208							81,323

			Total liabilities and stockholder's equity	$	570,288						$	678,236

Tax-equivalent net interest income							$	5,797						$	5,529

Interest rate spread(3)									4.25	%						3.26	%

Net interest margin(4)									4.66	%						3.89	%

(1): Nonaccrual loans are included in the Average Balance columns, and income recognized on these loans, if any, is included in the Interest Income/Expense columns. Interest income on loans includes fees on loans, which are not material in amount.

(2): Nontaxable interest income on securities was adjusted to a taxable yield assuming a tax rate of 34%.
(3): The interest rate spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4): The net interest margin is equal to net interest income, on a fully taxable-equivalent basis, divided by average interest-earning assets.

					Nine Month Period Ended September 30,
					2002							2001
					Average Balance			Interest Income/ Expense		Yield/ Rate		Average Balance			Interest Income/ Expense		Yield/ Rate
					(Dollars in thousands)
ASSETS
Interest-earning assets:
	Loans, net of unearned income(1)				$	282,698		$	15,280	7.21	%	$	333,077		$	21,374	8.56	%
	Securities(2)					206,194			8,244	5.33	%		174,698			8,558	6.53	%
	Interest-earning time deposits in other banks					5,107			72	1.88	%		502			19	5.05	%
	Federal funds sold					17,077			205	1.60	%		71,120			2,307	4.33	%

		Total interest-earning assets				511,076			23,801	6.21	%		579,397			32,258	7.42	%

Noninterest-earning assets:
	Cash and due from banks					24,918							32,901
	Intangible assets					32,974							47,424
	Premises and equipment					14,920							16,030
	Accrued interest receivable and other assets					17,935							14,945
	Allowance for possible loan losses					(7,210	)						(7,049	)

		Total noninterest-earning assets				83,537							104,251

			Total assets		$	594,613						$	683,648

LIABILITIES AND STOCKHOLDER'S EQUITY
Interest-bearing liabilities:
	Interest-bearing, savings and money market deposits				$	187,597		$	1,212	0.86	%	$	187,309		$	2,951	2.10	%
	Time deposits					221,981			5,305	3.19	%		299,609			12,777	5.69	%
	Federal funds purchased and securities sold under agreements to repurchase					180			1	0.74	%		126			3	3.17	%

			Total interest-bearing liabilities			409,758			6,518	2.12	%		487,044			15,731	4.31	%

Noninterest-bearing liabilities:
	Demand deposits					100,581							97,940
	Accrued interest payable and other liabilities					6,474							7,960

			Total noninterest-bearing liabilities			107,055							105,900

				Total liabilities		516,813							592,944
Guaranteed preferred beneficial interests in the Company's subordinated debentures						10,924							10,915
Stockholder's equity						66,876							79,789

				Total liabilities and stockholder's equity	$	594,613						$	683,648

Tax-equivalent net interest income								$	17,283						$	16,527

Interest rate spread(3)										4.09	%						3.11	%

Net interest margin(4)										4.51	%						3.80	%

(1): Nonaccrual loans are included in the Average Balance columns, and income recognized on these loans, if any, is included in the Interest Income/Expense columns. Interest income on loans includes fees on loans, which are not material in amount.
(2): Nontaxable interest income on securities was adjusted to a taxable yield assuming a tax rate of 34%.
(3): The interest rate spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(4): The net interest margin is equal to net interest income, on a fully taxable-equivalent basis, divided by average interest-earning assets.

The following table presents the changes in the components of net interest income and identifies the part of each change due to differences in the average volume of interest-earning assets and interest-bearing liabilities and the part of each change due to the average rate on those assets and liabilities. The changes in interest due to both rate and volume in the table have been allocated to volume or rate change in proportion to the absolute amounts of the change in each.

				Quarter Ended September 30, 2002 vs. 2001									Nine Month Period Ended September 30, 2002 vs. 2001
				Increase (Decrease) Due to Changes in									Increase (Decrease) Due to Changes in
				Volume			Rate			Total			Volume			Rate			Total
				(Dollars in thousands)									(Dollars in thousands)
Interest-earning assets:
	Loans, net of unearned income(1)			$	(650	)	$	(792	)	$	(1,442	)	$	(3,233	)	$	(2,861	)	$	(6,094	)
	Securities(2)				212			(517	)		(305	)		1,543			(1,857	)		(314	)
	Interest-earning time deposits in other banks				42			(20	)		22			174			(121	)		53
	Federal funds sold				(503	)		(60	)		(563	)		(1,753	)		(349	)		(2,102	)

		Total interest income			(899	)		(1,389	)		(2,288	)		(3,269	)		(5,188	)		(8,457	)

Interest-bearing liabilities:
	Deposits:
		Savings and money market deposits			(30	)		(347	)		(377	)		5			(1,744	)		(1,739	)
		Time deposits			(981	)		(1,197	)		(2,178	)		(3,310	)		(4,162	)		(7,472	)
		Federal funds purchased and securities sold under agreements to repurchase			0			(1	)		(1	)		1			(3	)		(2	)

			Total interest expense		(1,011	)		(1,545	)		(2,556	)		(3,304	)		(5,909	)		(9,213	)

Increase (decrease) in net interest income				$	112		$	156		$	268		$	35		$	721		$	756

(1): Nonaccrual loans have been included in average assets for the purposes of the computations, thereby reducing yields.
(2): Information with respect to tax-exempt securities is provided on a fully taxable-equivalent basis assuming a tax rate of 34%.

Provision for Loan Losses

The amount of the provision for loan losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, especially nonperforming and other potential problem loans. During these evaluations, consideration is given to such factors as: management's evaluation of specific loans; the level and composition of nonperforming loans; historical loss experience; results of examinations by regulatory agencies; an internal asset review process conducted by the Company; expectations of economic conditions and their impact on particular industries and individual borrowers; the market value of collateral; the strength of available guarantees; concentrations of credits; and other judgmental factors. The provisions for loan losses made for the quarter and nine month period ended September 30, 2002, were $78,000 and a reversal of $77,000, respectively, compared to provisions of $1,000,000 and $5,565,000 for the quarter and nine-month period ended September 30, 2001, respectively. These represent decreases of $922,000, and $5,642,000, respectively, over the comparative period. The substantially larger provisions in quarter and nine month periods ended September 30, 2001 were due to the deterioration, discovered in 2001 of the Company's collateral position on two particular large borrowing relationships, which relationships existed at the date of the Acquisition of the Company by State National. The reversals in the provision for the nine month period ended September 30, 2002 were primarily due to recoveries received during 2002.

Noninterest Income

Total noninterest income increased $302,000, or 23.6%, from $1,282,000 during the third quarter of 2001 to $1,584,000 during the third quarter of 2002. Total noninterest income also increased $781,000, or 20.0%, from $3,911,000 for the first nine months of 2001 to $4,692,000 for the first nine months of 2002.

Service charges on deposit accounts and on other types of services are the major source of noninterest income to the Company. This source of income increased $130,000, or 16.1%, from $810,000 during the third quarter of 2001 to $940,000 during the third quarter of 2002, and increased $363,000, or 14.3%, from $2,544,000 for the first nine months of 2001 to $2,907,000 for the first nine months of 2002. The increase in service charges on deposit accounts was primarily due to management emphasis placed on full collection of returned check fees in 2002.

Trust fees from the operation of the trust department of the Company increased $4,000, or 3.5%, from $113,000 during the third quarter of 2001 to $117,000 during the same period in 2002, and decreased $12,000, or 3.3%, from $381,000 for the first nine months of 2001 to $369,000 for the first nine months of 2002. The overall decrease was primarily the result of non-recurring income recorded in the first quarter of 2001.

Other income is the sum of several components of noninterest income including other customer service fees, brokerage service fees, credit and debit card income, safe deposit box rental income, Bank Owned Life Insurance ("BOLI") income, mortgage origination fees and other sources of miscellaneous income. Other income increased $168,000, or 46.8%, from $359,000 during the second quarter of 2001 to $527,000 during the third quarter of 2002, and increased $430,000, or 43.6%, from $986,000 for the first nine months of 2001 to $1,416,000 for the corresponding period in 2002. The increase in 2002 is primarily due to income generated from the BOLI, which was purchased in March 2001. The period ended September 30, 2001 includes seven months of income and the period ended September 30, 2002 includes nine months of income. The increase in 2002 is also due to an increase in mortgage origination fees. The Company had limited involvement in this market in early 2001 and, beginning in late 2001, began to increase the level of participation in this market.

Noninterest Expenses

Total noninterest expenses decreased $507,000, or 7.8%, from $6,496,000 during the third quarter of 2001 to $5,989,000 during the third quarter of 2002, and decreased $2,603,000, or 13.0%, from $20,083,000 during the first nine months of 2001 to $17,480,000 during the first nine months of 2002.

Salaries and employee benefits, the largest single component of noninterest expense, increased $143,000, or 5.5%, from $2,620,000 for the third quarter of 2001 to $2,763,000 for the corresponding period of 2002, and decreased $380,000, or 4.7%, from $8,175,000 for the nine month period ended September 30, 2001, to $7,795,000 for the corresponding period of 2002. The increase from quarter to quarter was primarily a result of employee raises which went into effect beginning July 1, 2002. The overall decrease between the nine month periods ended September 30, 2002 was primarily a result of efficiencies created after the completion of the Acquisition of the Company by State National and the Lubbock Merger.

Amortization of intangible assets decreased $552,000, or 53.9%, from $1,024,000 during the third quarter of 2001 to $472,000 during the third quarter of 2002, and decreased $1,652,000, or 53.9%, from $3,068,000 for the first nine months of 2001 to $1,416,000 for the first nine months of 2002. The majority of the decrease is due to the adoption of FAS 142. This statement of accounting standard requires that goodwill no longer be amortized beginning January 1, 2002. The balance of intangible amortization expense at September 30, 2001 included $1,371,000 of amortization related to goodwill. The remainder of the decrease is due to the overall decrease in core deposit intangible amortization

expense. As core deposit intangibles are amortized using an accelerated method, the amortization expense will decrease each year over the first half of the life of the core deposit intangible balances.

Net occupancy expense increased $22,000, or 2.3%, from $960,000 for the third quarter of 2001 to $982,000 for the same period in 2002, and increased $52,000, or 1.9%, from $2,812,000 for the first nine months of 2001 to $2,864,000 for the first nine months of 2002. The increase in net occupancy expense is primarily due to the costs associated with the removal of old documents and data. Document retention policies were reviewed and it was determined that older documents and data which were no longer required to be retained, were able to be destroyed and removed. Several storage facilities, which held some of these very old records, were cleaned out and many of the old documents were eliminated or moved to different storage facilities. The increase in expense is also related to clean up costs associated with an event of flooding that occurred at one of the Abilene branches. These increases were partially offset by decreases in furniture and equipment depreciation.

Professional fees, which include legal, accounting and other professional fees, increased $54,000, or 45.0%, from $120,000 during the third quarter of 2001 to $174,000 during the third quarter of 2002. The increase is due primarily to collection efforts occurring during the third quarter of 2002 as well as legal expenses related to the sale of the branches. These expenses also decreased $145,000, or 21.6%, from $672,000 during the first nine months of 2001 to $527,000 for the corresponding period of 2002, due primarily to nonrecurring accounting fees in the first quarter of 2001 associated with various regulatory filings that were required as a result of the Lubbock Merger.

Distributions on guaranteed preferred beneficial interests in the Company's subordinated debentures totaled $280,000 for the third quarter of 2001 and 2002, and totaled $839,000 for the first nine month of 2001 and $840,000 for the first nine months of 2002.

Communication expense decreased $42,000, or 17.4%, from $242,000 in the third quarter of 2001 to $200,000 in the third quarter of 2002, and decreased $79,000, or 11.5%, from $685,000 in the first nine months of 2001 to $606,000 for the corresponding period of 2002. The decrease is primarily due to efficiencies created over time, after the completion of the Lubbock Merger and the Acquisition of the Company by State National.

Data processing expense decreased $52,000, or 33.3%, from $156,000 in the third quarter of 2001 to $104,000 in the third quarter of 2002, and decreased $94,000, or 19.1%, from $493,000 in the first nine months of 2001 to $399,000 for the corresponding period of 2002. The decrease is primarily due to efficiencies created over time, after the completion of the Lubbock Merger and the Acquisition of the Company by State National.

Net costs applicable to other real estate and other repossessed assets consist of expenses associated with holding and maintaining repossessed assets, the net gain or loss on the sales of such assets, the write-down of the carrying value of the assets and any rental income that is credited as a reduction in expense. The Company recorded net costs of $12,000 in the third quarter of 2002 as compared to net costs of $56,000 in the third quarter of 2001 and recorded net costs of $10,000 for the first nine months of 2002 as compared to net costs of $44,000 for the same period in 2001. The decrease in net costs recorded during the nine months ended September 30, 2002 was related to the sale of other repossessed assets which were acquired many years ago, before the Acquisition of the Company by State National. These assets had been written off before the Acquisition due to the length of time the assets were on the books, so the entire sale was recorded as a gain.

Merger-related expenses decreased from $51,000 in the first nine months of 2001 to $0 in the same period in 2002. The merger related expenses recorded in 2001 were related to the Lubbock Merger.

Other noninterest expense includes, among many other items, stationary, printing and supplies expense, advertising and business development expense, postage, loan and collection expenses, armored car and courier fees, travel, insurance, ATM transaction expenses, regulatory examinations, franchise

taxes, dues and subscriptions, Federal Deposit Insurance Corporation ("FDIC") insurance expense and directors' fees. These expenses decreased $36,000, or 3.5%, from $1,038,000 during the third quarter of 2001 to $1,002,000 during the third quarter of 2002, and decreased $221,000, or 6.8%, from $3,244,000 for the first nine months of 2001 to $3,023,000 for the first nine months of 2002. The decrease in other expenses is primarily due to efficiencies created over time, after the completion of the Lubbock Merger and the Acquisition of the Company by State National.

Federal Income Taxes

The Company recorded a federal income tax benefit of $178,000 in the third quarter of 2001 compared to $264,000 in federal income tax expense in the third quarter of 2002, and recorded a federal income tax benefit of $1,553,000 in the first nine months of 2001 as compared to $1,302,000 in federal income tax expense in the same period for 2002. The benefit recorded during the first nine months of 2001 was due to the increased provision for loan losses, causing a loss for the period.

Impact of Inflation

The effects of inflation on the local economy and on the Company's operating results have been relatively modest during the past several years. Because substantially all of the Company's assets and liabilities are monetary in nature, such as cash, securities, loans and deposits, their values are less sensitive to the effects of inflation than to changing interest rates, which do not necessarily change in accordance with inflation rates. The Company tries to control the impact of interest rate fluctuations by managing the relationship between its interest rate-sensitive assets and liabilities. See "Analysis of Financial Condition—Interest Rate Sensitivity" herein.

Analysis of Financial Condition

Assets

Total assets decreased $75,271,000, or 11.8%, from $637,383,000 at December 31, 2001, to $562,112,000 at September 30, 2002. This decrease is primarily due to a decrease in deposits resulting from conservative deposit pricing and an overall decline in deposit rates.

Cash, Due From Banks and Interest-earning Time Deposits

The amount of total cash, due from banks and interest-earning time deposits decreased $15,829,000, or 43.89%, from $36,062,000 at December 31, 2001, to $20,233,000 at September 30, 2002. The decrease during the period is due primarily to a decrease in the balance required to be maintained with the Federal Reserve Bank. After an in-depth analysis performed by a third party, the Company was able to restructure many of its transaction accounts to reduce the overall required reserves, thereby decreasing the balance required to be kept with the Federal Reserve Bank. The decrease is also due to improved management of currency on hand.

Federal Funds Sold

Federal funds sold decreased $1,215,000, or 11.54%, from $10,528,000 at December 31, 2001, to $9,313,000 at September 30, 2002. The decrease is primarily due to shrinkage of the deposit balance.

Securities

Securities decreased $24,282,000, or 11.2%, from $216,112,000 at December 31, 2001, to $191,830,000 at September 30, 2002, due primarily to shrinkage of the deposit balance.

The Board of Directors of the Company reviews all securities transactions monthly and the securities portfolio periodically. The Company's current investment policy provides for the purchase of U.S. Treasury securities, U.S. government agency securities, mortgage-backed securities having average maturities of twelve years or less and for the purchase of state, county and municipal agencies' securities with maximum maturities of 10 years. The Company's policy is to maintain a securities portfolio with staggered maturities to meet its overall liquidity needs. Municipal securities must be rated A or better. Certain school district issues, however, are acceptable with a Baa rating. All securities totaling $191,830,000 are classified as available-for-sale and are carried at fair value at September 30, 2002. The decision to sell securities classified as available-for-sale is based upon management's assessment of changes in economic or financial market conditions.

Certain of the Company's securities are pledged to secure public and trust fund deposits and for other purposes required or permitted by law. At September 30, 2002, the book value of U.S. Treasury and other U.S. Government agency securities so pledged amounted to $37,427,000, or 19.5% of the total securities portfolio.

The following table summarizes the amounts and the distribution of the Company's securities held at the dates indicated.

		September 30, 2002				December 31, 2001
		Amount		%		Amount		%
		(Dollars in thousands)
Carrying value:
	U.S. Treasury securities and obligations of U.S. Government agencies and corporations	$	132,232	68.9	%	$	136,025	62.9	%
	Mortgage-backed securities and collateralized mortgage obligations		52,128	27.2			69,735	32.3
	Obligations of states and political subdivisions		3,603	1.9			7,109	3.3
	Other securities		3,867	2.0			3,243	1.5

Total carrying value of securities		$	191,830	100.0	%	$	216,112	100.0	%

Total fair value of securities		$	191,830			$	216,112

The following table provides the maturity distribution and weighted average interest rates of the Company's total securities portfolio at September 30, 2002. The yield has been computed by relating the forward income stream on the securities, plus or minus the anticipated amortization of premiums or accretion of discounts, to the carrying value of the securities. The book value of previous securities classified as held-to-maturity was their cost, adjusted for previous amortization or accretion. The

restatement of the yields on tax-exempt securities to a fully taxable-equivalent basis has been computed assuming a tax rate of 34%.

Type and Maturity Grouping at September 30, 2002				Principal Amount		Carrying Value		Estimated Fair Value		Weighted Average Yield
				(Dollars in thousands)
U.S. Treasury securities and obligations of U.S. Government agencies and corporations:
	Within one year			$	23,692	$	24,124	$	24,124	5.12	%
	After one but within five years				98,786		103,057		103,057	4.97	%
	After five but within ten years				4,317		5,051		5,051	6.98	%

		Total U.S. Treasury securities and obligations of U.S. Government agencies and corporations			126,795		132,232		132,232	5.07	%

Mortgage-backed securities and collateralized mortgage obligations					51,069		52,128		52,128	5.45	%

Obligations of states and political subdivisions:
	Within one year				441		447		447	7.05	%
	After one but within five years				2,280		2,370		2,370	7.55	%
	After five but within ten years				610		653		653	7.07	%
	After ten years				120		133		133	8.02	%

		Total obligations of states and political subdivisions			3,451		3,603		3,603	7.42	%

Other securities:
	Within one year				0		0		0	0.00	%
	After one but within five years				0		0		0	0.00	%
	After five but within ten years				0		0		0	0.00	%
	After ten years				3,867		3,867		3,867	1.74	%

		Total other securities			3,867		3,867		3,867	1.74	%

			Total securities	$	185,182	$	191,830	$	191,830	5.15	%

Loan Portfolio

Total loans, net of unearned income, decreased $17,310,000, or 5.7%, from $304,246,000 at December 31, 2001, to $286,936,000 at September 30, 2002. The decrease during the first nine months of 2002 was primarily a result of the pay down of loans with fewer renewals occurring due to current economic conditions.

The Company primarily makes installment loans to individuals and commercial and real estate loans to small to medium-sized businesses and professionals. The Company offers a variety of commercial lending products, including revolving lines of credit, letters of credit, working capital loans and loans to finance accounts receivable, inventory and equipment and various types of agriculture loans. Typically, the Company's commercial loans have floating rates of interest, are for varying terms (generally not exceeding five years), are personally guaranteed by the borrower and are collateralized by accounts receivable, inventory or other business assets.

The following table presents the Company's loan balances at the dates indicated separated by loan types.

			September 30, 2002		December 31, 2001
			(In thousands)
Real estate loans			$	137,692	$	135,544
Commercial loans				85,536		98,129
Loans to individuals				27,112		37,873
Agriculture and other loans				36,603		32,724

	Total loans			286,943		304,270
Less unearned income				7		24

		Loans, net of unearned income	$	286,936	$	304,246

Loan concentrations are considered to exist when there are amounts loaned to a multiple number of borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. The Company had no concentrations of loans at September 30, 2002, except for those described above and a geographic concentration of loans in West and North Texas. The Bank had no loans outstanding to foreign countries or borrowers headquartered in foreign countries at September 30, 2002.

Management of the Company may renew loans at maturity when requested by a customer whose financial strength appears to support such renewal or when such renewal appears to be in the Company's best interest. The Company requires payment of accrued interest in such instances and may adjust the rate of interest, require a principal reduction or modify other terms of the loan at the time of renewal.

The following table presents the distribution of the maturity of the Company's loans and the interest rate sensitivity of those loans, excluding loans to individuals, at September 30, 2002. The table also presents the portion of loans that have fixed interest rates or interest rates that fluctuate over the life of the loans in accordance with changes in the money market environment as represented by the prime rate.

		One Year and Less		One to Five Years		Over Five Years		Total Carrying Value
		(In thousands)
Real estate loans		$	66,144	$	62,113	$	9,435	$	137,692
Commercial loans			72,134		12,362		1,040		85,536
Agriculture and other loans			34,406		1,993		204		36,603

	Total loans	$	172,684	$	76,468	$	10,679	$	259,831

With fixed interest rates		$	43,053	$	67,607	$	8,012	$	118,672
With variable interest rates			129,631		8,861		2,667		141,159

	Total loans	$	172,684	$	76,468	$	10,679	$	259,831

Allowance for Loan Losses

Implicit in the Company's lending activities is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made and the creditworthiness of the borrower over the term of the loan. To reflect the currently perceived risk of loss associated with the Company's loan portfolio, additions are made to the Company's allowance for loan losses (the "allowance"). The

allowance is created by direct charges against income (the "provision" for loan losses), and the allowance is available to absorb probable loan losses. See "Analysis of Results of Operations—Provision for Loan Losses" above.

The allowance is reduced by loan charge-offs, increased by recoveries of loans previously charged off and increased or decreased by the loan loss provision to arrive at a balance determined by management to be appropriate. The Company's allowance was $6,929,000, or 2.4% of loans, net of unearned income, at September 30, 2002, compared to $6,525,000, or 2.2% of loans, net of unearned income, at December 31, 2001.

Credit and loan decisions are made by management and the Board of Directors of the Company in conformity with loan policies established by the Board of Directors of the Company. The Company's practice is to charge off any loan or portion of a loan when it is determined by management to be uncollectible due to the borrower's failure to meet repayment terms, the borrower's deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan's classification as a loss by regulatory examiners or for other reasons. The Company charged off $182,000 and $850,000 in loans during the third quarter and first nine months of 2002, respectively. Recoveries during the third quarter and first nine months of 2002 were $127,000 and $1,331,000, respectively.

The following table presents the provisions for loan losses, loans charged off and recoveries on loans previously charged off, the amount of the allowance, the average loans outstanding and certain pertinent ratios for the quarters and nine-month periods ended September 30, 2002 and 2001.

				Quarter Ended September 30,						Nine Month Period Ended September 30,
				2002			2001			2002			2001
				(Dollars in thousands)
Analysis of allowance for loan losses:
Balance, beginning of period				$	6,906		$	5,387		$	6,525		$	8,379
	Provision for loan losses				78			1,000			(77	)		5,565

					6,984			6,387			6,448			13,944

Loans charged off:
	Real estate loans				22			0			61			0
	Commercial loans				37			605			414			4,864
	Loans to individuals				123			235			375			870
	Agriculture other loans				0			0			0			2,892

		Total charge-offs			182			840			850			8,626

Recoveries of loans previously charged off:
	Real estate loans				0			0			20			2
	Commercial loans				76			606			1,115			747
	Loans to individuals				22			41			96			121
	Agriculture and other loans				29			0			100			6

		Total recoveries			127			647			1,331			876

			Net loans charged off (recovered)		55			193			(481	)		7,750

Balance, at September 30				$	6,929		$	6,194		$	6,929		$	6,194

Average loans outstanding, net of unearned income				$	282,552		$	313,939		$	282,698		$	333,077

Ratio of nonperforming loans to total loans, net of unearned income, at end of period					2.92	%		3.20	%		2.92	%		3.20	%

Ratio of net loan charge-offs (recoveries) to average loans outstanding, net of unearned income (annualized)					0.02	%		0.25	%		(0.17	)%		3.10	%

Ratio of allowance for loan losses to nonperforming loans, at end of period					82.61	%		60.95	%		82.61	%		60.95	%

Ratio of allowance for loan losses to total loans, net of unearned income, at end of period					2.41	%		1.95	%		2.41	%		1.95	%

The increase in the balance of the allowance from September 30, 2001 to September 30, 2002, is primarily due to the recording of $1,331,000 in recoveries. The majority of the recovery during the first nine months of 2002 was related to a substantial loan charge off of a particular large relationship, which occurred in the second quarter of 2001. Settlement of negotiations with borrowers occurred in the first quarter of 2002 and a portion of the loan balance, which was previously charged off, was recovered.

The amount of the allowance is established by management, based upon estimated risks inherent in the existing loan portfolio. The allowance is comprised of three components: specific reserves on identified problem loans, historical loss percentages applied to pools of loans with similar

characteristics, and an unallocated portion. Management reviews the loan portfolio on a periodic basis to evaluate potential problem loans. This review encompasses management's estimate of current economic conditions and the potential impact on various industries, prior loan loss experience and the financial conditions of individual borrowers. Loans that have been specifically identified as problem or nonperforming loans are reviewed on at least a quarterly basis, and management critically evaluates the prospect of ultimate losses arising from such loans, based on the borrower's financial condition and the value of available collateral. When a risk can be specifically quantified for a loan, that amount is specifically allocated in the allowance. In addition, the Company allocates the allowance based upon the historical loan loss experience of the different types of loans. Despite such allocation, both the allocated and unallocated portions of the allowance are available for charge-offs for all loans.

At September 30, 2002 and December 31, 2001, loans identified as being impaired consisted of loans placed on non-accrual status.

At September 30, 2002 and December 31, 2001, the recorded investment in loans that are considered to be impaired under FAS 114 was approximately $8,388,000 and $5,581,000, respectively. Included in this amount at September 30, 2002 and December 31, 2001, was approximately $8,353,000 and $4,710,000, respectively, of impaired loans for which the related specific reserve for loan losses was approximately $1,889,000 and $1,190,000, respectively. Impaired loans of $35,000 and $871,000 at September 30, 2002 and December 31, 2001, respectively, did not have a specific reserve for loan losses.

The following table shows the allocations in the allowance and the respective percentages of each loan category to total loans at September 30, 2002, and December 31, 2001.

			September 30, 2002				December 31, 2001
			Amount of Allowance Allocated to Category		Percent of Loans by Category to Loans, Net of Unearned Income		Amount of Allowance Allocated to Category		Percent of Loans by Category to Loans, Net of Unearned Income
			(Dollars in thousands)
Real estate loans			$	1,067	48.0	%	$	1,092	44.5	%
Commercial loans				1,777	29.8			1,714	32.3
Loans to individuals				699	9.4			868	12.4
Agriculture and other loans				222	12.8			19	10.8

	Total allocated			3,765	100.0	%		3,693	100.0	%

	Unallocated			3,164				2,832

		Total allowance for possible loan losses	$	6,929			$	6,525

Loan Review Process

The Company follows a loan review program to evaluate the credit risk in its loan portfolio. Through the loan review process, the Company maintains an internally classified loan list that, along with the list of nonperforming loans discussed herein, helps management assess the overall quality of the loan portfolio and the adequacy of the allowance. Loans classified as "substandard" are those loans with clear and defined weaknesses such as highly leveraged positions, unfavorable financial ratios, uncertain repayment sources, involvement in bankruptcy proceedings or poor financial condition, which may jeopardize recoverability of the loan. Loans classified as "doubtful" are those loans that have characteristics similar to substandard loans, but also have an increased risk that a loss may occur or at least a portion of the loan may require a charge-off if liquidated at present. Although loans classified as substandard do not duplicate loans classified as doubtful, both substandard and doubtful loans may

include some loans that are past due at least 90 days, are on nonaccrual status or have been restructured. Loans classified as "loss" are those loans that are usually in the process of being charged off. There were no loans designated as loss at September 30, 2002.

In addition to the internally classified loans, the Company also has a "watch list" of loans that further assists management in monitoring its loan portfolio. A loan is included on the watch list if it demonstrates one or more deficiencies requiring attention in the near term or if the loan's ratios have weakened to a point where more frequent monitoring is warranted. These loans do not have all the characteristics of a classified loan (substandard, doubtful or loss), but do have weakened elements as compared with those of a satisfactory credit. Management of the Company reviews these loans in assessing the adequacy of the allowance. Substantially all of the loans on the watch list at September 30, 2002, were current and paying in accordance with loan terms. See "Nonperforming Assets" herein.

Nonperforming Assets

Nonperforming assets consist of nonaccrual, past due and restructured loans. A past due loan is an accruing loan that is contractually past due 90 days or more as to principal or interest payments. Loans on which management does not expect to collect interest in the normal course of business are placed on nonaccrual or are restructured. When a loan is placed on nonaccrual, any interest previously accrued but not yet collected is reversed against current income unless, in the opinion of management, the outstanding interest remains collectible. Thereafter, interest is included in income only to the extent of cash received. A loan is restored to accrual status when all interest and principal payments are current and the borrower has demonstrated to management the ability to make payments of principal and interest as scheduled.

A "troubled debt restructuring" is a restructured loan upon which interest accrues at a below market rate or upon which certain principal has been forgiven so as to aid the borrower in the final repayment of the loan, with any interest previously accrued, but not yet collected, being reversed against current income. Interest is accrued based upon the new loan terms.

Nonperforming loans are fully or substantially collateralized by assets, with any excess of loan balances over collateral values allocated in the allowance. Assets acquired through foreclosure are carried at the lower of cost or estimated fair value, net of estimated costs of disposal, if any. See "Other Real Estate and Other Repossessed Assets" herein.

Foreclosures on defaulted loans result in the Company acquiring other real estate and other repossessed assets. Accordingly, the Company incurs other expenses, specifically net costs applicable to other real estate and other repossessed assets, in maintaining, insuring and selling such assets. The Company attempts to convert nonperforming loans into interest-earning assets, although usually at a lower dollar amount than the face value of such loans, either through liquidation of the collateral securing the loan or through intensified collection efforts.

The following table lists nonaccrual, past due and restructured loans and other real estate and other repossessed assets at September 30, 2002, and December 31, 2001.

	September 30, 2002		December 31, 2001
	(In thousands)
Nonaccrual loans	$	8,388	$	5,581
Accruing loans contractually past due over 90 days		27		223
Restructured loans		17		29
Other real estate and other repossessed assets		629		691

Total nonperforming assets	$	9,061	$	6,524

The gross interest income that would have been recorded during the third quarter and first nine months of 2002 on the Company's nonaccrual loans if such loans had been current, in accordance with the original terms thereof and outstanding throughout the period or, if shorter, since origination, was approximately $132,000 and $321,000, respectively. No interest income was actually recorded (received) on loans that were on nonaccrual during the nine month period ended September 30, 2002.

A potential problem loan is defined as a loan where information about possible credit problems of the borrower is known, causing management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may result in the inclusion of such loan in one of the nonperforming asset categories. The Company does not believe it has any potential problem loans other than those reported in the previous table or those included on the watch list as discussed above.

Intangible Assets

Intangible assets decreased $17,069,000, or 39.0%, from $43,719,000 at December 31, 2001, to $26,650,000 at September 30, 2002. This decrease was primarily due to the impairment of goodwill of $15,642,000 recorded in the first quarter of 2002. The remaining decrease is caused by core deposit intangible amortization expense recorded during the first nine months of 2002.

Premises and Equipment

Premises and equipment decreased $602,000, or 3.9%, during the first nine months of 2002, from $15,380,000 at December 31, 2002, to $14,778,000 at September 30, 2002. The decrease was primarily due to depreciation recorded during 2002 totaling $1,111,000. This decrease was partially offset by additions to premises and equipment.

Other Assets

Other assets consists of accrued interest receivable, other real estate and other repossessed assets and various other assets. The balance of other assets increased $1,440,000, or 8.1%, from $17,861,000 at December 31, 2001 to $19,301,000 at September 30, 2002.

Accrued interest receivable consists of interest that has accrued on securities and loans, but is not yet payable under the terms of the related agreements. The balance of accrued interest receivable decreased $668,000, or 12.6%, from $5,321,000 at December 31, 2001, to $4,653,000 at September 30, 2002. The decrease was primarily a result of a decrease in loans and the reclassification during the period of certain loans to nonaccrual status where interest previously accrued is reversed. Of the total balance at September 30, 2002, $2,525,000, or 54.3%, was interest accrued on loans and $2,128,000, or 45.7%, was interest accrued on securities. The amounts of accrued interest receivable and percentages attributable to loans and securities at December 31, 2001, were $2,953,000, or 55.5%, and $2,368,000, or 44.5%, respectively.

Other real estate and other repossessed assets consist of real property and other assets unrelated to banking premises or facilities. Income derived from other real estate and other repossessed assets, if any, is generally less than that which would have been earned as interest at the original contract rates on the related loans. At September 30, 2002, and December 31, 2001, other real estate and other repossessed assets had an aggregate book value of $629,000 and $691,000, respectively. Other real estate and other repossessed assets decreased $62,000, or 9.0%, during the first nine months of 2002. Of the September 30, 2002 balance, $494,000 represents four commercial and agricultural properties, $112,000 represents four residential properties, and $23,000 represents nine repossessed vehicles and other equipment.

The balance of other assets increased $2,170,000, or 18.3%, to $14,019,000 at September 30, 2002, from $11,849,000 at December 31, 2001, as a result of the additional purchase of bank owned life insurance on various officers of the Bank.

Deposits

The Company's lending and investing activities are funded almost entirely by core deposits, 57.4% of which are demand, savings and money market deposits at September 30, 2002. Total deposits decreased $64,228,000, or 11.8%, from $544,030,000 at December 31, 2001, to $479,802,000 at September 30, 2002. The reduction in the deposit balance was primarily due to decreases in interest rates paid on time deposit accounts causing a lower demand for these accounts. The reduction was one which management planned, specifically in an effort to realign our deposit mix. The Company does not have any brokered deposits.

The following table presents the average amounts of, and the average rates paid on, deposits of the Company for the quarters and nine month periods ended September 30, 2002 and 2001.

		Quarter Ended September 30,								Nine Month Period Ended September 30,
		2002				2001				2002				2001
		Average Amount		Average Rate		Average Amount		Average Rate		Average Amount		Average Rate		Average Amount		Average Rate
		(Dollars in thousands)								(Dollars in thousands)
Noninterest-bearing demand deposits		$	97,758	—	%	$	103,096	—	%	$	100,581	—	%	$	97,940	—	%
Interest-bearing demand, savings and money market deposits			184,028	0.83	%		191,491	1.59	%		187,597	0.86	%		187,309	2.10	%
Time deposits of less than $100,000			135,903	2.79	%		178,562	5.06	%		145,451	3.10	%		187,676	5.56	%
Time deposits of $100,000 or more			71,612	3.13	%		104,197	5.48	%		76,530	3.35	%		111,933	5.89	%

	Total deposits	$	489,301	1.55	%	$	577,346	3.08	%	$	510,159	1.70	%	$	584,858	3.59	%

The maturity distribution of time deposits of $100,000 or more at September 30, 2002 is presented below.

		At September 30, 2002
		(In thousands)
3 months or less		$	25,259
Over 3 through 6 months			25,321
Over 6 through 12 months			12,536
Over 12 months			9,418

	Total time deposits of $100,000 or more	$	72,534

Time deposits of $100,000 or more are a more volatile and costly source of funds than other deposits and are most likely to affect the Company's future earnings because of interest rate sensitivity. At September 30, 2002, and December 31, 2001, deposits of $100,000 or more represented approximately 12.9% and 13.9%, respectively, of the Company's total assets.

Fed Funds Purchased and Securities Sold Under Agreement to Repurchase

The balance of fed funds purchased and securities sold under agreement to repurchase increased $40,000, or 26.5%, from $151,000 at December 31, 2001 to $191,000 at September 30, 2002.

Other Liabilities

Other liabilities consists of accrued interest payable and other liabilities accrued for various types of expenses and current and deferred federal income taxes payable. Other liabilities increased $36,000, or 1.0% from $6,903,000 at December 31, 2001 to $6,939,000 at September 30, 2002.

Accrued interest payable consists of interest that has accrued on deposits, but is not yet payable under the terms of the related agreements. The balance of accrued interest payable decreased $735,000, or 50.3%, from $1,462,000 at December 31, 2001, to $727,000 at September 30, 2002, due to a decrease in interest-bearing deposit balances as well as decreases in interest rates being paid on interest-bearing time deposits during the first nine months of 2002.

The most significant components of other liabilities are amounts accrued for various types of expenses and current and deferred federal income taxes payable. The balance of other liabilities increased $771,000 or 14.2%, from $5,441,000 at December 31, 2001, to $6,212,000 at September 30,

2002. The increase in other liabilities is primarily due to an increase in the deferred tax liability related to the unrealized gain or loss of available for sale securities.

Interest Rate Sensitivity

Interest rate risk arises when an interest-earning asset matures or when its rate of interest changes in a time frame different from that of the supporting interest-bearing liability. The Company seeks to minimize the difference between the amount of interest-earning assets and the amount of interest-bearing liabilities that could change interest rates in the same time frame in an attempt to reduce the risk of significant adverse effects on the Company's net interest income caused by interest rate changes. The Company does not attempt to match each interest-earning asset with a specific interest-bearing liability. Instead, as shown in the following table, it aggregates all of its interest-earning assets and interest-bearing liabilities to determine the difference between the two in specific time frames. This difference is known as the rate-sensitivity gap. A company is considered to be asset sensitive, or having a positive gap, when the amount of interest earning-assets maturing or repricing within a given period exceeds the amount of its interest-bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or having a negative gap, when the amount of its interest-bearing liabilities maturing or repricing within a given time period exceeds the amount of its interest-earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative gap would tend to affect net income adversely, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Maintaining a balanced position will reduce risk associated with interest rate changes, but it will not guarantee a stable interest rate spread because the various rates within a time frame may change by differing amounts and occasionally change in different directions. Management regularly monitors the interest sensitivity position and considers this position in its decisions in regard to interest rates and maturities for interest-earning assets acquired and interest-bearing liabilities accepted.

In adjusting the Company's asset/liability position, management attempts to manage the Company's interest rate risk while enhancing net interest margins. The rates, terms and interest rate indices of the Company's interest-earning assets result primarily from the Company's strategy of investing in loans and securities, which permit the Company to limit its exposure to interest rate risk, together with credit risk, while at the same time achieving a positive and relatively stable interest rate spread from the difference between the income earned on interest-earning assets and the cost of interest-bearing liabilities.

The Company's ratios of interest-sensitive assets to interest-sensitive liabilities, as shown in the following table, are 71.1% at the 90-day interval, 64.8% at the 180-day interval and 77.5% at the 365-day interval at September 30, 2002. Currently, the Company is in a liability-sensitive position at the three intervals. However, the Company had $178,520,000 of interest-bearing demand, savings and money market deposits at September 30, 2002, on which, from the Company's experience, interest rates change more slowly. Therefore, excluding these types of deposits, the Company's interest-sensitive assets to interest-sensitive liabilities ratio at the 365-day interval would have been 154.33% at September 30, 2002. The interest sensitivity position is presented as of a point in time and can be modified to some extent by management as changing conditions dictate.

The following table shows the interest rate sensitivity position of the Company at September 30, 2002.

			Cumulative Volumes Subject to Repricing Within									Volumes Subject to Repricing After 1 Year
			90 Days			180 Days			365 Days			Volumes Subject to Repricing After 1 Year		Total
			(Dollars in thousands)
Interest-earning assets:
	Federal funds sold		$	9,313		$	9,313		$	9,313		$	—	$	9,313
	Securities			23,824			37,001			87,291			104,539		191,830
	Loans, net of unearned income			144,013			156,067			181,260			105,676		286,936

		Total interest-earning assets		177,150			202,381			277,864			210,215		488,079

Interest-bearing liabilities:
	Demand, savings and money market deposits			178,520			178,520			178,520			—		178,520
	Securities Sold Under Agreement to Repurchase			191			191			191			—		191
	Time deposits			70,344			133,716			179,853			24,441		204,294

	Total interest-bearing liabilities			249,055			312,427			358,564			24,441		383,005

Rate-sensitivity gap(1)			$	(71,905	)	$	(110,046	)	$	(80,700	)	$	185,774	$	105,074

Rate-sensitivity ratio(2)				71.1	%		64.8	%		77.5	%

(1): Rate-sensitive interest-earning assets less rate-sensitive interest-bearing liabilities.
(2): Rate-sensitive interest-earning assets divided by rate-sensitive interest-bearing liabilities.

In addition to the gap analysis, determining the sensitivity of future earnings to an instantaneous hypothetical plus or minus basis point parallel rate shock can be accomplished through the use of simulation modeling. Simulation of earnings included the modeling of the balance sheet as an ongoing entity. Balance sheet items are modeled to project net interest income based on an instantaneous hypothetical change in interest rates. Floors are established within the simulation model on the interest rate changes for different interest earning and interest bearing products during periods of low interest rates. The resulting net interest income for the next twelve-month period is compared to the net interest income amount calculated using flat rates. This difference represents the Bank's earnings sensitivity to an instantaneous plus or minus basis point parallel rate shock. The following table displays the percent change in net interest income simulated at various instantaneous plus or minus basis point parallel rate shocks.

	Net Interest Income Period Ended September 30,
Changes in Interest Rates	Net Interest Income Period Ended September 30,
Changes in Interest Rates	2002		2001
+200	8.9	%	7.8	%
+100	6.3	%	4.5	%
0	0.0	%	0.0	%
-100	(5.3	)%	(4.6	)%
-200	(7.9	)%	(10.1	)%

The results are within the policy limits established by the Company's Board of Directors.

Selected Financial Ratios

The following table presents selected financial ratios (annualized) for the quarters and nine month periods ended September 30, 2002 and 2001.

		Quarter Ended September 30,				Nine Month Period Ended September 30,
		2002		2001		2002		2001
Income (loss) Before Cumulative Effect of a Change in Accounting Principle to:
	Average assets	0.71	%	(0.33	)%	0.71	%	(0.74	)%
	Average interest-earning assets	0.82		(0.39	)	0.82		(0.88	)
	Average stockholder's equity	6.42		(2.73	)	6.28		(6.36	)
Net income (loss) to:
	Average assets	0.71		(0.33	)	(2.80	)	(0.74	)
	Average interest-earning assets	0.82		(0.39	)	(3.26	)	(0.88	)
	Average stockholder's equity	6.42		(2.73	)	(24.91	)	(6.36	)
Dividend payout(1) to:
	Net income	N/A		N/A		N/A		N/A
	Average stockholder's equity	N/A		N/A		N/A		N/A
Average stockholder's equity to:
	Average total assets	11.08		11.99		11.25		11.67
	Average loans(2)	22.37		25.90		23.66		23.96
	Average total deposits	12.92		14.09		13.11		13.64
Average interest-earning assets to:
	Average total assets	87.29		83.88		85.95		84.75
	Average total deposits	101.73		98.53		100.18		99.07
	Average total liabilities	100.33		97.08		98.89		97.72
Ratio to total average deposits of:
	Average loans(2)	57.75		54.38		55.41		56.95
	Average noninterest bearing deposits	19.98		17.86		19.72		16.75
	Average interest-bearing deposits	80.02		82.14		80.28		83.25
Total interest expense to total interest income		24.70		44.57		27.53		48.77
Efficiency Ratio(3)		71.13		75.95		69.62		79.26

(1): Dividends on Common Stock only.
(2): Before allowance for possible loan losses.
(3): Calculated as noninterest expense less distributions on guaranteed preferred beneficial interests in the Company's subordinated debentures, amortization of intangibles and expenses related to other real estate and other repossessed assets divided by the sum of net interest income before provision for loan losses and total noninterest income, excluding securities gains and losses.

Liquidity

The Bank

Liquidity with respect to a financial institution is the ability to meet its short-term needs for cash without suffering an unfavorable impact on its on-going operations. The need for the Bank to maintain funds on hand arises principally from maturities of short-term borrowings, deposit withdrawals, customers' borrowing needs and the maintenance of reserve requirements. Liquidity with respect to a financial institution can be met from either assets or liabilities. On the asset side, the primary sources of liquidity are cash and due from banks, federal funds sold, maturities of securities and scheduled repayments and maturities of loans. The Bank maintains adequate levels of cash and near-cash investments to meet its day-to-day needs. Cash and due from banks averaged $18,548,000 and

$24,918,000 during the third quarter and first nine months of 2002, respectively, and $30,683,000 and $32,901,000 during the third quarter and first nine months of 2001, respectively. These amounts comprised 3.3% and 4.2% of average total assets during the third quarter and first nine months of 2002, respectively, and 4.5% and 4.8% of average total assets during the third quarter and first nine months of 2001, respectively.

The average level of securities, interest-earning time deposits in other banks and federal funds sold was $215,224,000 and $228,378,000 during the third quarter and first nine months of 2002, respectively, and $254,932,000 and $246,320,000 during the third quarter and first nine months of 2001, respectively.

Securities totaling $1,414,000 were sold during the quarter and the nine month period ended September 30, 2002 and a total of $59,919,000 of securities classified as available-for-sale were sold during the quarter and nine month period ended September 30, 2001. At September 30, 2002, $24,571,000, or 12.8%, of the Company's securities portfolio, excluding mortgage-backed securities, matured within one year, and $105,427,000, or 55.0%, excluding mortgage-backed securities, matured after one but within five years. The Bank's commercial and real estate lending activities are concentrated in loans with maturities of less than five years with both fixed and adjustable interest rates, while its installment lending activities are concentrated in loans with maturities of three to five years and with primarily fixed interest rates. At September 30, 2002, approximately $181,260,000, or 63.2%, of the Company's loans, net of unearned income, matured within one year and/or had adjustable interest rates. Approximately $172,684,000, or 66.5%, of the Company's loans (excluding loans to individuals) matured within one year and/or had adjustable interest rates. See "Analysis of Financial Condition—Loan Portfolio" above.

On the liability side, the principal sources of liquidity are deposits, borrowed funds and the accessibility to money and capital markets. Customer deposits are by far the largest source of funds. During the third quarter and first nine months of 2002, the Company's average deposits were $489,301,000 and $510,159,000, or 85.8% and 85.8%, of average total assets, respectively, compared to $577,346,000 and $584,858,000, or 85.1% and 85.6% of average total assets, respectively, during the third quarter and first nine months of 2001. The Company attracts its deposits primarily from individuals and businesses located within its market areas. See "Analysis of Financial Condition—Deposits" above.

The Company

The Company depends on the Bank for liquidity in the form of cash flow, primarily to meet distribution requirements on the Company's subordinated debentures, which payments, in turn, are used to meet distribution requirements on Independent Capital's Trust Preferred Securities and to cover other operating expenses. The Company's immediate liquidity needs have been and can continue to be satisfied by advances from the Company's parent company.

The payment of dividends to the Company is subject to applicable law and the scrutiny of regulatory authorities. Dividends paid by the Bank to Independent Financial during the third quarter and first nine months of 2002 were $0 and $0, respectively; in turn, Independent Financial and Independent Capital paid dividends to the Company totaling $9,000 and $26,000, respectively, during the same time periods of 2002. Dividends paid by the Bank to Independent Financial during the third quarter and first nine months of 2001 were $0 and $700,000, respectively; in turn, Independent Financial and Independent Capital paid dividends to the Company of $9,000 and $726,000, respectively, during the same time periods. At September 30, 2002, there were no dividends available for payment to Independent Financial by the Bank without first obtaining regulatory approval.

Current tax liabilities totaling $372,000 and $1,614,000 were paid by the Bank to the Company during the third quarter and the nine month period ended September 30, 2002, respectively. There

were no current tax liabilities generated by the Bank during the third quarter and the nine month period ended September 30, 2001 due to the pre-tax loss incurred by the Bank.

Capital Resources

At September 30, 2002, stockholders' equity totaled $64,250,000, or 11.4% of total assets, compared to $75,381,000, or 11.8% of total assets, at December 31, 2001.

Bank regulatory authorities in the United States have risk-based capital standards by which all bank holding companies and banks are evaluated in terms of capital adequacy. These guidelines relate a banking company's capital to the risk profile of its assets. The risk-based capital standards require all banking companies to have Tier 1 capital of at least 4% and total capital (Tier 1 and Tier 2 capital) of at least 8% of risk-weighted assets, and to be designated as well-capitalized, the banking company must have Tier 1 and total capital ratios of at least 6% and 10%, respectively. For the Company, Tier 1 capital includes common stockholders' equity (net of available for sale fair value adjustment) and qualifying guaranteed preferred beneficial interests in the Company's subordinated debentures, reduced by intangible assets net of the deferred tax liability associated with the core deposit intangible, and any deferred tax asset disallowed for regulatory capital purposes. For the Company, Tier 2 capital is comprised of the remainder of the guaranteed preferred beneficial interests in the Company's subordinated debentures not qualifying for Tier 1 capital and the qualifying amount of the allowance for loan losses.

Banking regulators also have leverage ratio requirements. The leverage ratio requirement is measured as the ratio of Tier 1 capital to adjusted quarterly average assets. The leverage ratio standards require all banking companies to have a minimum leverage ratio of at least 4% and to be designated as well-capitalized, the banking company must have a leverage ratio of at least 5%. The following table provides a calculation of the Company's risk-based capital and leverage ratios and a comparison of the Company's and the Bank's risk-based capital ratios and leverage ratios to the minimum regulatory and well-capitalized minimum requirements at September 30, 2002.

		September 30, 2002
		(In thousands)
Tier 1 capital		$	46,965
Tier 2 capital			4,211

	Total capital	$	51,176

Net risk-weighted assets		$	334,191

Adjusted quarterly average assets		$	540,931

	Regulatory Minimum		"Well Capitalized" Minimum		Actual Ratios at September 30, 2002
The Company
Tier 1 capital to net risk-weighted assets ratio	4.00	%	6.00	%	14.05	%
Total capital to net risk-weighted assets ratio	8.00		10.00		15.31
Leverage ratio	4.00		5.00		8.68
The Bank
Tier 1 capital to net risk-weighted assets ratio	4.00	%	6.00	%	14.39	%
Total capital to net risk-weighted assets ratio	8.00		10.00		15.65
Leverage ratio	4.00		5.00		8.97

The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities, as well as reflect the actual performance and expected risk of loss on multi-family mortgages. This law also requires each federal banking agency to specify the levels at which an insured institution would be considered "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." Under the FDIC's regulations, the Company and the Bank were both "well capitalized" at September 30, 2002.

The Company's ability to generate capital internally through retention of earnings and access to capital markets is essential for satisfying the capital guidelines for bank holding companies as prescribed by the Federal Reserve Board.

The payment of dividends on the Common Stock is determined by the Company's Board of Directors in light of circumstances and conditions then existing, including the earnings of the Company and the Bank, funding requirements and financial condition and applicable laws and regulations. The Company's ability to pay cash dividends is restricted by the requirement that it maintain a certain level of capital as discussed above in accordance with regulatory guidelines. The Federal Reserve Board has promulgated a policy prohibiting bank holding companies from paying dividends on common stock unless such bank holding company can pay such dividends from current earnings.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the Company's market risk profile from the information disclosed in the Company's Form 10-K for the year ended December 31, 2001.

Item 4. Controls and Procedures

Based on the evaluation of the Company's disclosure controls and procedures as of a date within 90 days of the filing date of the quarterly report, each of Tom C. Nichols, the Chairman, President and Chief Executive Officer, and Don E. Cosby, Executive Vice President and Chief Financial Officer, have concluded that in their judgment the Company's disclosure controls and procedures are designed to ensure that material information relating to the Company's subsidiaries, is make known to such officers by others within the Company or its subsidiaries.

There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, the Company is a party in litigation proceedings incidental to the normal course of its business. In the opinion of management, the ultimate liability, if any, resulting from known, current litigation, either singularly or in the aggregate, would not reasonably be expected to have a material adverse effect on the Company's financial position, results of operations, or cash flows.

Item 2. Changes in Securities.

None

Item 3. Defaults upon Senior Securities.

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information.

None

Item 6. Exhibits and Reports on Form 8-K.

(a): Exhibits

Exhibit 99.1 Chief Executive Officer and Chief Financial Officer Certification

(b): Reports on Form 8-K

None

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 14, 2002		Independent Bankshares, Inc. (Registrant)
		By:	/s/ DON E. COSBY Don E. Cosby Executive Vice President & Chief Financial Officer (Duly authorized Officer and Principal Financial Officer)

I, Tom C. Nichols, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Independent Bankshares, Inc.;

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.

The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

		Date:		November 14, 2002
		/s/ Tom C. Nichols Tom C. Nichols Chairman, President & Chief Executive Officer

I, Don E. Cosby, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Independent Bankshares, Inc.;

2.

3.

4.

a): designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b): evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c): presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

a): all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b): any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and

6.: The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

		Date:		November 14, 2002
		/s/ Don E. Cosby Don E. Cosby Executive Vice President & Chief Financial Officer

QuickLinks

PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2002 AND DECEMBER 31, 2001 (Unaudited) (In Thousands)
INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE QUARTERS AND NINE MONTH PERIOD ENDED SEPTEMBER 30, 2002 AND 2001 (Unaudited) (In Thousands)
INDEPENDENT BANKSHARES, INC. A WHOLLY OWNED SUBSIDIARY OF STATE NATIONAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTH PERIODS ENDED SEPTEMBER 30, 2002 and 2001 (Unaudited) (In Thousands)
INDEPENDENT BANKSHARES, INC. NOTES TO INTERIMCONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Liquidity
Capital Resources
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II OTHER INFORMATION

Item 1. Legal Proceedings.

Item 2. Changes in Securities.

Item 3. Defaults upon Senior Securities.

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information.

Item 6. Exhibits and Reports on Form 8-K.

SIGNATURE